Robert B. Jones, JD, CPA, CEBS, CSCP

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Philadelphia Chapter of NACD
2014 Compensation UpdateFollowing the Right
Path in 2014 Robert B. Jones, JD, CPA, CEBS,
CSCP CEO, Innovative Compensation and Benefits
Concepts, LLC Philadelphia, PA May 14th,
2014

• Robert B. Jones, JD, CPA, CEBS, CSCP
• CEO, Innovative Compensation and Benefits
  Concepts, LLC
• Conshohocken, PA
• November 22, 2011Robert B. Jones, JD, CPA, CEBS,
  CSCP
• CEO, Innovative Compensation and Benefits
  Concepts, LLC
• Philadelphia, PA
• Februrary 22, 2011

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Quotable

• Despite our concerns regarding the goals of the
  original provision, we understand that as a
  matter of U.S. law, SEC is mandated to pass a
  rule implementing it. In a previous comment
  letter..sent Nov. 18, 2010, NACD noted an
  unfavorable cost-benefit ratio for the rule,
  with no perceivable benefits and significant
  costs, and urged the SEC to implement this
  provision with extreme care. We still believe
  this to be true. NACD letter of 12/1/13
• The pushback is that this calculation between
  top executive pay and median employee pay is
  actually a really hard calculation to make. It
  can be extremely hard with a global corporation
  with hundreds of thousands of employees or even
  millions of employees in the case of a company
  like Wal-Mart to figure out what exactly the
  median employee's paid, especially since some
  work part time, some may work in other nations.
• Lynn Stout, Cornell Law
  Professor, NPR, 10/26/13

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Todays Agenda

• 1. Brief Review of executive pay practice trends
  for 2014.
• 2. Brief Review of best practices for Say on Pay
  in 2014.
• 3. The New Dodd-Frank SEC Pay Ratio Rule--Value
  or Folly?

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The Changing Compensation EnvironmentCompanies
Continue to Re-Think their Compensation Strategy
Innovative Compensation and Benefits Concepts
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The changing compensation environment-rethinking
the compensation strategy
Significant Forces Affecting Executive
Compensation in 2014

• Regulators
• SEC
• FASB and IASB

• Financial
• Manage earnings expense
• Manage dilution
• Cost vs. perceived value
• Economic conditions

• Lawmakers
• Sarbanes-Oxley Act
• Deferred comp reform
• More from Congress?

Impact on Future Designs

• Stakeholders
• Shareholders
• Proxy advisory firms
• Employees/Retirees
• Labor unions
• Corporate governance

• Stock Exchanges
• New proposed governance rules
• Listing requirements

• Media
• Heightened vigilance and skepticism

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Major Issues in 2014

• In a perfect storm 3 main issues are surfacing
  at once
• How can organizations be confident that their
  compensation programs are fully aligned with 2014
  business objectives?
• What does the current regulatory environment mean
  for the future design of executive remuneration
  programs?
• How can organizations be sure that their rewards
  programs attract, retain, and motivate their top
  executives for the long term?

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1. Executive pay practice trends for 2014
Innovative Compensation and Benefits Concepts
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Key Equity Compensation Trends from 2013

• For the 3rd year in a row, long-term performance
  shares increased in prevalence. According to one
  major survey, they are now used by 81 of the Top
  250 (up from 75 in the 2012 report), and are the
  most prevalent form of equity. Restricted stock
  usage has also increased this year, from 58 to
  63, while the use of stock options and long-term
  cash plans remains largely unchanged.
• Companies are still emphasizing a portfolio
  approach to their long-term incentive programs
  (LTIPs), with an increasing number of companies
  using 3 LTI grant types (39), while those
  granting one or two types declined.
• Total Shareholder Return (TSR) has become the
  most prevalent performance metric (for the first
  time) for LTIPs, featured in 50 of all
  performance awards, as companies continue to look
  for ways to tie executive compensation to
  shareholder experience at the urging of proxy
  advisory firms and shareholder advocates.
• Overall, the design of LTIPs has become more
  complex as the number of grant types, number of
  performance award measures, and prevalence of the
  concurrent use of absolute and relative measures
  all increased.
• Source Frederic W. Cook Co. 2013 Top 250
  report

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Current Equity Pay Trends ---2

• Because of the rising stock market last year,
  while the total dollar value of LTIP awards
  increased, the number of shares required for
  those awards decreased.
• The use of full-value awards continues to
  increase, with companies showing a median equity
  mix of 67 full-value awards and 33 appreciation
  awards based on the number of shares granted, and
  86 full-value awards and 14 appreciation awards
  based on the fair value of equity awarded in the
  year.
• For the near term, it seems clear that full-value
  awards, particularly performance-based awards,
  will continue to be the primary award vehicle in
  the LTIP portfolio of large U.S. companies.
  However, while decreasing in influence, stock
  appreciation awards are in no danger of
  disappearing and continue to have a place in the
  LTI mix. The evolution in equity award usage will
  continue.
• Source Frederic W. Cook Co. 2013 Top 250
  report

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So whats the problem ?......

• Major Disconnect between the views of investors
  and the views of directors
• Nearly 3 in 4 investors (72) say that the
  executive pay model in the US has led to
  excessive CEO pay levels while only 1 in 5
  directors (20) say the executive pay model has
  led to excessive pay levels
• 7 in 10 directors (70) say the executive pay
  model at most companies is closely linked to
  company strategy, compared with just 1 in 3
  investors (34).
• Less than one-fourth of directors (23) say
  executive pay is overly influenced by management,
  versus two-thirds of investors (66).
• Source Towers Watson, January 16, 2014 Evolving
  Director and Investor Views of Executive Pay in
  the Say-on-Pay Era

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Current Equity Pay Trends --3

• According to one survey, stock grants are most
  common, followed by performance shares/units.
• Stock Grants/Awards 81
• Performance Shares/Units 72
• Stock Options/SARs 54
• Source Deloitte/ NASPP Annual 2013 SurveyTop
  Trends in Equity Plan Design

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Say on Pay for 2014
Innovative Compensation and Benefits Concepts
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Executive Summary

• Key Takeaways from the Past Year
• Compensation committees have become more
  disciplined and effective in analyzing and
  designing executive compensation programs.
• The adoption of Say-on-Pay for publicly-traded
  companies and additional shareholder scrutiny of
  executive compensation arrangements have
  definitely played a role in the increase of
  granting performance-based awards.
• Most companies, even those with good Say-on-Pay
  shareholder voting results, have been proactively
  reaching out to shareholders over the past few
  years to interactively discuss, review and
  analyze what their key shareholders think about
  executive compensation.

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Say on Pay Results

• 3,363 companies held Say on Pay votes in 2013
• 73 companies have failed with an average 60
  Against vote
• (Two additional companies received less than 50
  For but considered the vote a win because For
  votes outnumbered Against votes due to
  abstentions).
• 15 companies failed previous votes
• 70.6 of companies have received a greater than
  90 For vote
• 8.4 Average Against vote
• 1.8 Abstentions
• One company, Looksmart, received 100 Against
  on their Say on Pay vote

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Say on Pay Results ---2

• Total fail rate 2.2
• Average vote for those who passed 91
• Average vote for those who failed 37
• gt90 For vote 70.6
• 70-90 For vote 20.8
• 50-70 For vote 6.2
• lt50 For vote 2.3
• - - -

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Say on Pay Results---3

• ISS lt70 approval rating---will have to address
  any perceived shortfalls in procedures, votes,
  etc.
• Glass-Lewis lt75 of vote, will be looking for
  an explanation from the Company

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NACD Pay for Performance research

• December, 2013 NACD Paper on P4P
• 1. Need for Standard Definitions
• 2. Need for consistent time horizons oriented to
  the Long Term
• 3. Need for Disclosure beyond the CEO
• 4. Importance of Board Judgment and Company
  Context

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Pay for Performance is Still Key

• Bottom Line
• Companies need to stress in their CDA/proxies
  the linkage between pay-for-performance and what
  they have accomplished as a management team
  during. the past year. Pay-for-performance is now
  the mantra for compensation consultants and
  investorsand compensation committees too.
• Companies also need to show how their pay
  practices have aligned with the performance of
  the Company and the performance of the pay
  packages for the NEOs

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Important to Also View Pay for Performance from
the Proxy Advisors Perspective

• Public companies also must develop a clear
  understanding of the perspective of proxy
  advisory services that analyze company practices
  and advise institutional investors on the voting
  of their shares.
• One of the most well-known proxy advisors, (ISS)
  uses detailed criteria to assess companies
  executive pay practices
• These criteria include
• The long-term relationship between CEO pay and
  total shareholder return
• The portion of total compensation delivered via
  performance-based vehicles
• The use, type and disclosure of performance
  measures and goals
• The existence of poor pay policies and
  practices.

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CEO Pay Ratio Controversy
Innovative Compensation and Benefits Concepts
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The Pay-Ratio Rule in Broad Terms

• The pay ratio rule is a provision in the
  Dodd-Frank Act that requires the SEC to publish
  rules requiring public companies to disclose the
  ratio of the CEOs total compensation to the
  median employees total compensation.
• The average multiple of CEO compensation to that
  of rank-and-file workers at companies in the SP
  500 Index is 204, according to data compiled by
  Bloomberg.

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What do opponents and proponents say ?

• Critics say the rule will do the following
• The ratio will be misleading
• The pay ratio is a headline statistic, not an
  actionable tool
• Compliance will be costly
• Supporters say the rule will do the following
• Provide greater transparency
• Reduce pay

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Tempest Brewing Many Business Groups Urge
Repeal of CEO-to-Worker Pay Ratio Disclosure Rule

• The provision was reportedly a last-minute
  addition to the Dodd-Frank legislation.
• Many business groups have been fighting this
  provision.
• A proposed rule was issued on September 18, 2013
  with the SEC voting 3-2 along partisan lines.
• A 60-day comment period for the SEC began with
  the publication of the rule. Comments were due by
  December 2nd, 2013, but are expected well into
  2014.

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Many Business Groups Urge Repeal of CEO-to-Worker
Pay Ratio Disclosure Rule ---2

• On the day the proposed rule was announced, the
  SEC said it had already received 22,860 comment
  letters and a petitions sender that was not
  disclosed with 84,700 signatories. Many of the
  comment letters were form letters. The actual
  number of unique letters was 260, fairly evenly
  divided between pro and con.
• From the pro rule camp, the SEC received
  letters from labor groups such as AFL-CIO, UAW
  Retiree Medical Benefits Trust, (left-leaning)
  Institute for Policy Studies, and the Independent
  Drucker Institute, Calvert Investment Management,
  and Americans for Financial Reform.
• From the against the rule camp, the SEC
  received letters from NACD, American Bar
  Association and numerous law firms, Society of
  Human Resources Management (SHRM), Towers Watson,
  Pay Governance, Meridian Compensation Partners,
  and the Society of Corporate Secretaries and
  Governance Professionals.

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Business Groups Urge Repeal of CEO-to-Worker Pay
Ratio Disclosure Rule --3

• The new rule, required under the Dodd-Frank Act,
  would not prescribe a specific methodology for
  companies to use in calculating a pay ratio. 
  Instead, companies would have the flexibility to
  determine the median annual total compensation of
  its employees in a way that best suits its
  particular circumstances.
• In a letter sent to SEC Chair Mary Schapiro,
  nearly two dozen business groups asked the agency
  to "engage in expanded public outreach and
  consideration of alternatives" before moving
  forward with implementing the new rule.
• The proposed rule would not specify any required
  calculation methodologies for identifying the
  median employee in terms of total compensation
  for all employees.  Instead, it would allow
  companies to select a methodology that is
  appropriate to the size and structure of their
  own businesses and the way they compensate
  employees. 

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Business Groups Urge Repeal of CEO-to-Worker Pay
Ratio Disclosure Rule --4

• For example, a company would be permitted to
  identify the median employee based on total
  compensation using either its full employee
  population or a statistical sample of that
  population.
• A company could, for example, identify the median
  of its population or sample
• Using annual total compensation as determined
  under existing executive compensation rules.
• Using any consistently used compensation measure
  such as compensation amounts reported in its
  payroll or tax records.  A company would then
  calculate the annual total compensation for that
  median employee in accordance with the definition
  of total compensation set forth in the SECs
  executive compensation rules.

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CEO-to-Worker Pay Ratio Rule--Early Returns

• For total direct compensation overall, one
  consulting firm found that the median CEO pay
  multiple among all companies studied is 25.8x,
  although there was considerable variability
  within the studied companies.
• While they found no compelling differences
  between industry groupings, they found that the
  CEO pay multiple is most closely correlated to
  organizational size the larger the company the
  higher the multiple.
• The second most influential factor for CEO pay
  multiples appears to be a companys degree of
  globalization. The finding was that the CEO pay
  multiple to non-US employees is more than twice
  as large as the multiple to US employees.
• Source Radford

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CEO pay has clearly risen....
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But, the CEO job today is much more demanding

• Research from some sources shows that the CEOs
  pay package compared to the size of the SP 500
  has tracked its growth very closely since World
  War II. (Columbia University Professor
  Guadalupes study using proxies since WWII). She
  argues that 3 factors increased company size, a
  strong market for generalists, and global
  competition have helped to cause the rapid
  increase in CEO pay over the past 30 years.
• The CEOs job is extraordinarily complex in 2014,
  encompassing many more skillsets than in 1980,
  nearly 35 years ago. The world is much more
  complicated today. One more quote Where is the
  outrage at professional athletes who make that
  kind of money? Managing an international company
  with thousands of employees is more important
  than winning a championship. There is a
  similarity though, in that its worth paying top
  dollar for the very best. If you have a billion
  dollars a year in revenue, you don't want to
  skimp on who you put in charge of that.----Adam
  Allen post

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The view in support of the SEC pay ratio rule

• What is so important about the pay ratio numbers
  ?
• Peter Drucker, the father of business management,
  famously said the CEO-to worker salary ratio
  should not exceed 201, which is what existed in
  the United States in 1965. Beyond that, managers
  will see an increase in 'resentment and falling
  morale,' said Drucker. (Reportedly, Andrew
  Carnegie also had his own ratio in mind).
• Many supporters say that the rule will continue
  to draw public attention to the disparity in
  executive pay compared to the rank and file, even
  causing executive pay to not continue to rise at
  such a high rate.
• A few experts have suggested that the IRS make
  CEO pay a non-deductible business expense when it
  is higher than a given number such as 100 times
  the minimum wage.

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The view in support of the SEC pay ratio rule ---2

• Across the pond--------
• The movement in Europe is to make say on pay
  votes not merely advisory but mandatory. In Great
  Britain, where it has become a binding vote, UK
  firms responded to negative say on pay voting
  outcomes by removing controversial CEO pay
  practices criticized as rewards for failure
  (e.g., generous severance contracts) and
  increasing the sensitivity of pay to poor
  realizations of performance.
• Swiss voters, (from a traditionally
  business-friendly and conservative European
  country) on November 24th, 2013 decisively
  rejected a proposal to cap pay for top
  executives. Final results showed that votes
  against were 65.3 to 34.7. The ground-breaking
  proposal would have meant executives would have
  been unable to earn more in a month than their
  lowest-paid workers in a year (12x). In March,
  voters approved a measure that boosted
  shareholders power over managerial salaries and
  banned one-off bonuses so-called "golden
  hellos" and "golden goodbyes".

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The view in support of the SEC pay ratio rule ---3

• California lawmakers are proposing higher tax
  rates on companies that pay their chief executive
  officers more than 100 times the wages of a
  typical worker. The bill, which would likewise
  give tax breaks to companies with lower ratios,
  passed the Senate Governance and Finance
  Committee yesterday in a 5-2 vote, with Democrats
  in favor and Republicans opposed. California
  would be the first state to penalize or reward
  publicly traded corporations for their
  compensation practices.
• Whole Foods is reportedly one of the few public
  companies to disclose that it maintains a fixed
  ratio between executives and worker pay (cash
  compensation limited in 2013 to 19 times the
  average annual wage).

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NACDs comments (12/1/13 letter to the SEC)

• Our views reflect recent surveys of our members,
  as well as the values implicit in the findings of
  NACDs thought leadership groups such as our Blue
  Ribbon Commissions and Fortune 500 committee
  chair advisory councils. This letter also
  incorporates perspectives from NACD chapter
  leader roundtables, director forums, director
  education programs, and other events focused on
  promoting effective governance practices.
• The pay ratio provision appears to have two main
  goalsone related to information and one related
  to social change. Its original sponsor wrote it
  so that investors and the general public know
  whether public companies pay practices are fair
  to their employees, especially compared to their
  highly compensated CEOs. In addition, some
  supporters clearly hope that the disclosure will
  have the ultimate effect of narrowing
  differentials in pay. We do not believe that the
  rule accomplishes the first goal, and question
  the appropriateness of the second.

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Whats the view opposing the SEC pay ratio
rule?---4

• Several pieces of legislation have called for the
  repeal of the act in whole or in part
• HR 46---filed by Michelle Bachmann, (R-MN)
• S. 20----filed by Sen. David Vitter (R-LA)
• The US House Financial Services Committee voted
  in favor of the Burdensome Data Collection Relief
  Act (HR 1135), sponsored by Rep. Bill Huizenga
  (R-MI) to repeal the entire law.
• 2 main legal cases are pending
• A group of banks challenged the law in State
  National Bank of Big Spring v. Geithner (appealed
  to higher court) in September the attorney
  generals of Michigan, Oklahoma and South Carolina
  joined the case as plaintiffs
• National Association of Manufacturers (NAM),
  Chamber of Commerce, and the Business Roundtable
  in July sued the SEC in the lower court and got
  rejected NAM has filed a notice of intent to
  appeal the July 23rd,decision.

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Actions to Consider
Innovative Compensation and Benefits Concepts
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What Actions Should Employers Consider ?

• Review compensation strategy in light of current
  environment
• Review your Compensation Committees usage of
  peer groups and how they fit into the overall
  evaluation of executive pay.
• Examine your employees situation from a Total
  Rewards standpointconsider the total picture
• Promote stock ownership for employees wherever
  possibleowning a piece of the rock is important
• Review your Board governance and compensation
  practices
• Monitor the ongoing programs carefully each year
  based on your Compensation Philosophy and your
  targets

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Any Questions ???